beyondbrics

Investors in South Korea shunned risk today – selling equities and the won, and moving money into bonds – after a website run by North Korean exiles reported that Kim Jong-Il ordered the country to be “combat-ready” in a broadcast to the hermit nation last week.

The Kospi index of stocks fell by 2.8 per cent, having been down as much as 4.5 per cent during the session. Defence-related shares performed well, with Speco and Victek both gaining over 10 per cent, according to Bloomberg.

The Korean won fell heavily on the reports – losing 3.7 per cent against the yen – a 10-month low. South Korea’s central bank and government will meet tomorrow to discuss ways of calming financial markets, reports Reuters.

Although today’s news is a clear sign of escalating tensions, it is not wholly unexpected. In a note on May 21, Eurasia group warned that further provocation from the North was likely [our emphasis]:

South Korea is unlikely to conduct any harsh reprisals on its own, and the international response will likely be symbolic, as China seems sure to water down any UN sanctions. But Pyongyang, which denies involvement in the attack, will probably use the opportunity to step up its provocations in order to rally support for Kim Jong-il’s regime at home and in order to squeeze more aid from the international community. Despite such behavior, the major players all have a stake in stability. Barring a North Korean act that makes conflict unavoidable, therefore, an uneasy calm is likely to prevail.

Standard Chartered seems to agree. In a note yesterday, the bank said the most likely response from South Korea would be the closure of its Kaesong industrial complex in the North – where it employs 40,000 North Koreans. The bank’s expectation is for stalemate:

Further military conflicts are unlikely, as they would significantly raise the risk of a full-scale war given the mutual defence treaty between South Korea and the US and the mutual aid treaty between North Korea and China. Financial markets will eventually stabilise as market participants become accustomed to the changed situation, although an announcement of the suspension of the Kaesong complex could cause minor market turmoil.

Yesterday the South Korean president Lee Myung-Bak gave a speech at the country’s War Museum, where he detailed a suspension of trade and investment, and closure of sea lanes to North Korean commerical ships. But Lee stopped short of closing Kaesong. Instead the government will reduce South Korean staff numbers and halt all new investment there. Prof. Kim Young-soo of Sogang University told the Chosun Ilbo:

“The Kaesong industrial park is a symbol of inter-Korean cooperation. The government apparently feared it would be branded forever as the party opposing reunification if it shuts the industrial park.”

For a final word, we turn to the Korea Times op-ed piece entitled ‘All sticks, no carrots for changing NK’ – written in response the Lee’s speech:

As the President says, the peninsula is at a critical turning point, either for better or for worse. The two Koreas should seek ways of making sure hostilities are housed only in the War Museum for mutual prosperity. It takes two to tango.

Related reading:
What can you buy from North Korea? – Slate